Disruptive Innovation

Kompas/Handining

.

She is not yet 30 years old. The blond woman still looks young, but her ideas and intelligence inspire awe. I am amazed. It was the summer of 2015, but a cool breeze blew from the promontory. I recall Mark Twain, who said that the coldest season in the United States was summer in San Francisco. Twain was right.

The young woman accompanied me when I was invited to visit a number of major technology companies in Silicon Valley. When I asked about the average age of the people who worked there, she answered, "Lately it is becoming older, the late 20s." There was a tone of of discontent at the end of her sentence. I choked. It was then that I realized that, to the young people in Silicon Valley, I was a dinosaur!

Redefining work

Here, I see how young people talk about brilliant ideas. Then how should a regulator position themselves in a changing world? To be honest, I am not clever enough to give an answer. The world is still guessing as well. However, there are several things that may need discussing.

First, is the change revolutionary? We experienced the first industrial revolution, which transformed production methods and the social order, improved productivity and changed standards of living. The invention of the steam engine changed the production method. The textile industry grew rapidly, but we witnessed the dark history of the working class. We read with sadness the novels Oliver Twist by Charles Dickens or Germinal by Emile Zola. However, the nightmare that machines would replace human workers did not entirely come true.

Humans passed the era with an important note from Joseph Schumpeter: creative destruction provided new job opportunities in the long term. It also encouraged prosperity. Barry Eichengreen of the University of California, Berkeley wrote: What happened was not the loss of work, but the redefinition of work. Just look: it is likely that the profession of nurses, accountants and other jobs will not be lost. However, in the future, they will require analytical skills to take advantage of big data and technology.

This is the problem: the transformation into a new skill set requires education or training. Unfortunately, the government provides limited training facilities. The government budget is also limited. Now, what? Invite the private sector to implement on-the-job training. This can be facilitated by offering a tax deduction when they provide training or vocational education for new skills.

Second, the Bank of England’s stress test shows how financial technology has had an impact on falling banking revenues, even though it should be noted that, in the long term, this will increase opportunities for the banking sector. In a number of countries all over the world, including Indonesia, we are witnessing a tug-of-war between conventional and new businesses. We see it in the issues of Uber, Gojek, fintech, Airbnb and increasingly fierce conflicts.

Following the concept of economist Mancur Olson in his seminal work, The Logic of Collective Action, we can guess: those who have been marginalized by disruptive innovation are focused and organized. In contrast, those who are benefiting from the change are widespread. Therefore, political pressure from disadvantaged groups will be stronger than from consumers that are enjoying digital technology.

If this happens, there is a tendency for a regulator in a democratic system to maintain the status quo rather than support innovation. Actually, innovation is badly needed. I cannot imagine how financial inclusion or the economy can grow if the regulations on financial technology are rigid. In this case, regulators must draw a fine line between innovation and protection.

Changing thinking

Third, regulators can no longer rely on the old way of thinking. This revolution in information technology penetrates things that were once considered impossible. Those studying economics know that it is nearly impossible to apply different prices (price discrimination) to each person. The reason is that limited information is available per individual. Even if this could be done, the prices would be very high and could be applied only to super-rich consumers (high networth individuals).

In the future, big data information will enable personalized (bespoke) products that could be provided en masse at at relatively low prices. This means that products or prices could be adjusted to an individual’s tastes and purchasing power.

I would not be surprised if insurance, for example, could be adjusted to individual needs. The policy period could be adjusted to days or even hours. People would no longer need to pay a high premium because the policy period is short and its coverage is specific.

I would guess that in the future, bank interest rates could also be different for different individuals based on their risk profiles as well as in their investment types. Therefore, the cost of loan monitoring would be cheaper. Various niche markets will be created and will change at any time. It will be difficult to regulate such innovations.

In November 2017 in Tokyo, I had the chance to discuss this with the Japanese Financial Services Authority. We agreed that the way of thinking had to be changed. Regulations had to change from static to dynamic supervision, and could no longer regulate details. Regulations must focus more on basic principles, such as consumer protection, level playing fields and ensuring openness. If they try to regulate technical and detailed problems, there is a risk that the regulations will soon become obsolete because of constant innovation.

Here arises the problem: Can regulators become dynamic and flexible? The main criticism of bureaucracy is its inflexibility. Bureaucracy also moves according to the uniform principles of regulations. Then how should it face the dynamics of products that are increasingly personal, flexible and require discretion?

Income inequality

Third, disruptive innovations can drive income inequality in the short term. It gives multiple benefits to a small group of people who succeed in developing their ideas, while in the short term, unskilled workers are on the brink of losing their jobs. In the long term, the workers will possibly find new jobs, but they would require new skills as well. Those who have no skills will be sidelined.

This adjustment process can be very bitter, and has serious political economy implications. In October 2017, when I spoke at a Harvard University conference, I had the chance to have a long discussion with Jeffry Frieden, a Harvard political economy professor. We discussed why anti-globalization and identity politics were strengthening and expanding in many countries, including the United States, Europe, Australia, Indonesia and many others.

According to Frieden, this was not specific to the US, Indonesia or Europe. It was happening simultaneously in a number of countries, so the explanation cannot be specific to one country. Frieden proposed a hypothesis: Income inequality and job losses had encouraged the strengthening of identity politics. Consistent with this, economist Dani Rodrik pointed out that economic inequality will lead to political polarization, either through identity politics or polarization of the rich and the poor.

This is a big theme in political economy. There is no single answer to this problem. Other political, ideological and sociological factors certainly play a role. However, apart from that, Freiden\'s hypothesis could be relevant for the future. Erik Brynjolfsson from the Massachusetts Institute of Technology warned that technology was an important factor in explaining income inequality in the US today. Interestingly, instead of blaming technology as the cause, the reactions that emerged were identity politics ala Donald Trump.

I believe the governments in a number of countries in the world, including Indonesia, will be faced with a difficult choice. Curbing technology and innovation would cause economic stagnation and worsen welfare. The consumer class – I am reluctant to call it the middle class – are professional complainers. As consumers, they are enjoying this change. They will demand that innovation continues. We still recall how the government soon canceled its plan to ban Gojek because of the people\'s protests.

On the other hand, increasing inequality will force the government to take a side. The tug-of-war will become increasingly difficult in this democratic era. The government needs to offer protection so the adjustment process will be less bitter, but not curb innovation. The difficulty is that there is no formula for this.

Dialogs between digital economy players and regulators have become very important. Unfortunately, time is not with us. Changes are happening rapidly.

I still remember the young woman’s response when I asked the average age of Silicon Valley workers: ”It is getting older, Sir, it is in the late 20s now.” There was a tone of disappointment and worry at the end of her sentence. I was also worried, but for another reason: If we do not change, we will become history.

Muhammad Chatib Basri

Lecturer, Economics and Business School of the University of Indonesia